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Working Paper
Number 13/17
Some international trends in the
regulation of mortgage markets:
Implications for Spain
Madrid, April 2013
Economic Analysis
13/17 Working Paper
Madrid, April 2013
Some international trends in the regulation of
mortgage markets: Implications for Spain
Santiago Fernández de Lis, Saifeddine Chaibi, Jose Félix Izquierdo, Félix Lores, Ana Rubio and
Jaime Zurita
April 2013
Abstract
In this document, the main characteristics of the mortgage markets regulation in developed
countries will be analyzed, trying to extract implications in terms of the resilience of the
different systems during this crisis. The note is organized in four sections, covering the most
relevant issues of (i) the mortgage product, (ii) the financial entities that offer these products,
(iii) the client to whom these products are sold and (iv) the relationship between mortgage
regulation and macroprudential oversight.
Keywords: mortgage, regulation, developed countries, loan-to-value, responsible lending, tax,
covered bonds.
JEL: G210, R210, R310, E620.
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Executive Summary
This document analyses the main characteristics and trends in the mortgage markets
regulation in developed countries, extracting implications from the different degree of
resilience of the different systems during this crisis, as well as lessons for the potential
improvements that could be implemented in Spain. One of the general features identified is a
high dispersion in the models, reflecting the fact that mortgages markets are local in nature,
depending on legal and institutional factors. At the same time, however, the reliance on
wholesale markets for the funding of mortgages implies that these securities have a global
dimension. The contrast between local primary mortgage markets (in which lenders make
loans to borrowers) and global secondary markets (in which banks sell these loans to third
parties) is one of the main characteristics of mortgage markets. This tension is very present in
current regulatory debates, and is very relevant for the Spanish case, because a significant part
of Spanish covered bonds are in the hands of non-resident investors.
There is a variety of interest rate schemes for mortgages across developed countries. In some
countries variable rates are the rule, whereas in others they are the exception, constituting a
good example of the dispersion in the mortgages models of developed countries. In fact, there
seems not to be a general trend toward increasing the proportion of variable or fixed rates, as
heterogeneous factors play a significant role (culture, funding, yield curve, early repayment
penalties…). The Spanish mortgage market is dominated by variable interest rates, which
account for around 97% of the loans. In the present crisis, the low interest rate environment
implies that borrowing at variable rates has protected the debtors, improving their affordability
ratios and reducing Non Performing Loans (NPLs); but an excessive reliance on Adjustable
Rate Mortgages (ARM) entails a vulnerability from the macro-prudential point of view, because
of the risk of rate increases during the duration of the contract (in some cases up to 40 years).
The predominance of one form of mortgages over the other suggests some deficiencies in
pricing and/or regulation. Indeed, it would be beneficial to achieve a more balanced split
between fixed and variable rate mortgages. In order to achieve this target, the cap on the
penalty for early repayment could be lowered (or even eliminated) for Fixed Rate Mortgages
(FRM), as in countries where the latter are the norm. Also, the offer of mixed rate mortgages
(where the rate is fixed for a certain period) could be encouraged. Furthermore, a better
dissemination of pre-contractual information to consumers about the pros and cons of the
different mortgage products would make their decision-making process more efficient and less
costly.
From the funding perspective, the use of covered bonds has largely supported the
development of the mortgage market in Europe. As shown in this crisis, covered bonds
provide a background of legal certainty that results in significant advantages compared to the
use of other types of funding. Issuers of covered bonds obtain a resilient funding source,
whereas investors are protected by the double guarantee inherent in covered bonds, and
benefit at the same time from a relatively high secondary market liquidity. Moreover, the use
of covered bonds has several macroeconomic benefits and helps to maintain financial stability.
Spanish covered bonds (cédulas) are similar to other EU countries' mortgage backed covered
bonds, having other systems both advantages and disadvantages. Certain aspects of covered
bonds in other European countries could be used to improve Spanish regulation (lower LTV
limits, requirement to publish detailed data on the composition of the cover assets, periodic
reassessment of the value of the properties used as collateral, replacement of the maturing or
non-performing assets and appointment of a cover pool monitor by the Central Bank).
During the last few years, regulation on consumer protection has been reinforced in many
countries in order to avoid over-indebtedness and borrower default. In that vein, the EC
Directive on credit agreements relating to residential property tackles some material consumer
protection issues, and should lead to desirable harmonization, in the context of a process
towards banking union. However, the Directive fails to tackle relevant issues, such as crossborder mortgages with foreign collateral. The proliferation of regulatory initiatives at national,
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regional and international level may result in regulatory conflicts, mostly in Europe. Since
different countries show different features with regard to real estate structure, cultural
background and socioeconomic policies, some leeway must be provided to national
supervisors in order to adapt the new regulation to their own needs. But this should not mask
the fact that maintaining a competitive environment and a Euro-wide level-playing field is
probably the best contribution regulators can make to ensure consumer protection.
Governments usually encourage housing investment through different fiscal tools due to
perceived positive externalities of home ownership. However, tax incentives to favor home
ownership could result in more exposure to housing bubbles. The development of the rental
market and a neutral tax treatment of property vs. rent seem to be a good practice. The
elimination of tax deductions for the purchase of new houses by the Spanish government in
July 2012 is in line with this consensus.
Since the origin of the crisis can be placed in the housing market, regulation of mortgage
operations must ensure financial stability from a macroprudential perspective. In that respect,
many countries adopted loan-to-value (LTV) limits. In some emerging countries, debt-to-income
ratios have also been used with the same purpose. According to international evidence, these
measures are relatively effective in preventing housing prices bubbles in emerging markets,
but they are perhaps too intrusive for more developed financial systems. Alternative measures
based on incentives for low LTV origination should be explored for more developed mortgage
markets. In the case of Spain, dynamic provisions had success in limiting the growth of credit
during the boom phase, but the severity and length of the current crisis made these measures
insufficient.
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2. The mortgage product
The interest rate to be charged for a mortgage is one of its most relevant characteristics. It is
usual to distinguish between Fixed Rate Mortgages (FRM) and Adjustable Rate Mortgages
(ARM). But in practice the modalities of interest rates present a wider variety. According to the
1
interest rate calculation method, mortgages can have :
1. Fixed interest rate: interest rates are negotiated before signing the contract and remain
unchanged throughout the duration of the loan.
2. Initial period fixed rate: the rate is fixed for an initial period, after which the interest rate can
remain fixed or become variable.
-
Rollover/Renegotiable-rate mortgage: the interest rate is always fixed, but its level is
renegotiated.
-
Hybrid-rate mortgage: after an initial period with fixed interest rate (normally more
than one year), the rate becomes variable.
Normally, mortgages are classified depending on the length of the initial period:
1<initial fixed rate period (years) <=5
5<initial fixed rate period (years) <=10
10<initial fixed rate period (years)
Obviously, the first type is close to an ARM, whereas the third type is close to a pure FRM.
3. Variable rate: the rate can vary periodically (monthly, quarterly, half-yearly, yearly), in
some cases after an initial period of one year with a fixed rate. In any case, rates change at
least once a year.
In this case the negotiations between borrower and lender are related to the reference
interest rate and its periodic revision:
-
Reviewable-rate mortgages: interest rate is determined by the lender periodically.
-
Indexed/Referenced-rate: rate changes according to a previously negotiated index.
Interest rate practices across countries
As shown in chart 11 there is a high heterogeneity in the mortgage interest rate determination
across countries. In fact, there seems not to be a general trend toward increasing the
proportion of variable or fixed rates.
In particular, there is a significant proportion of long term fixed interest rate mortgages in the
US, Denmark and France. One of the main characteristics of these mortgages is the prepayment penalty during the fixed-rate period. In France the penalty is applied often and it can
be up to three per cent of outstanding balance or three month’s interest.
In contrast, Australia, Ireland, Korea and Spain are characterized by variable rates, and the UK
has a relatively similar model, with predominance of short-term fixed rates. The bias towards
2
adjustable rates is generally the result of a high and variable inflation history .
Mortgage markets in Canada, the Netherlands and Switzerland are dominated by medium and
short term fixed interest rate mortgages, in which the interest rate is fixed for a period of one
1
2
: See Research Institute for Housing America, 2010
: See Campbell, 2012
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to five years and renewed according to the evolution of the reference rate (rollover). Usually,
these loans have a pre-payment penalty during the fixed-rate period.
There does not seem to be a clear relation between the interest rate model and the resilience
of the mortgage markets. Some markets like the Canadian or Australian have a mix of variable
and short or medium term fixed rates, while in Germany or the Netherlands there is a higher
proportion of fixed rates. The US relies on fixed rates, but is relatively prone to crises. The fact
that variable rates are predominant in Spain cannot be considered prima facie as a weakness,
although it exposes borrowers to greater variation of the terms of the loan. In certain crisis (like
the present one) the predominance of ARM can be a source of resilience, to the extent that the
housing bust is accompanied by lower interest rates. In other crises, however, the downturn is
the result of tighter monetary policies, and ARM mortgages exacerbate the vulnerability of
debtors.
It could be argued that the predominance of one form of mortgages over the other suggests
some deficiencies in pricing and/or regulation.
Chart 1
Mortgages’ interest variability, % of total
Fixed
Medium term fixed
Short term fixed
United
Kingdom
Spain
Canada
Netherlands
Germany
France
Denmark
USA
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Variable
Source: RBA, CHMC, KHFC, EMF, GPG, MBA and S&P
In each country, there is one kind of mortgage that has become the most representative:
In US: long-term fixed rate mortgages with minimal pre-payment penalties and automatic
refinancing.
In Denmark: medium term fixed interest rate up to 2 years and then variable
In Germany: renegotiable rate with a fixed period of 5 to 10 years.
In Spain: variable interest which usually floats every 6 or 12 months, according to an
official reference rate
In France: fixed rate for the total maturity of the loan.
Factors to determine the election of mortgages’
interest rate formula: market characteristics
What are the main factors behind the election of a type of mortgage (ARM vs. FRM)? Apart
from the interest rate, there are other factors that may influence lenders and debtors. In fact,
there seems not to be a general trend toward increasing the proportion of variable or fixed
rates, as these heterogeneous factors play a significant role (culture, funding, yield curve, early
repayment penalties…).
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Cultural differences
Cultural factors include issues such as housing regulation, taxation, borrowers’ risk aversion,
the frequency of house moves and bank funding options. In the U.K., where the proportion of
variable interest rate mortgages is relevant, homebuyers prefer them because the initial
monthly payments are lower. Additionally, in the U.K., people usually move house several
times in their lifetime, so they prefer variable interest rate mortgages to avoid incurring in early
repayment penalties.
Funding
Capital markets can provide funding at longer terms than deposits. Therefore, in countries
where there are stable sources of wholesale funding, like covered bonds, fixed rate mortgages
are more relevant. For example in Germany and Denmark there is a large tradition of funding
via covered bonds, which explains the importance of fixed rate mortgages. Conversely, in
countries such as Greece and Italy, where retail deposits are a relevant funding source, variable
rate mortgages have a higher weight. Spain is an exception in this regard, with a prevalence of
ARM and a very developed covered bonds market.
Yield curve
As the yield curve predicts the behavior of interest rates in the future, this instrument can
influence the mortgage choice. At the end of the 90’s and at the beginning of the past decade,
interest rates decreased in the Eurozone, and the yield curve predicted further cuts.
Consequently, long term interest rates were decreased and became more attractive to
borrowers, and long term fixed mortgages increased in some countries, like the U.K. However,
when euribor increased at the end of the last decade, the behavior was the opposite.
In the case of Spain, where ARMs were dominant since the development of mortgage markets
in the 1980s due to high and volatile inflation, the proportion of variable rates increased
further in the 90’s due to several factors: interest rates fell as a result of Euro adoption, prepayment penalties were restrictively regulated irrespective of the interest rate modality and
competition for mortgages increased as a result of the liberalization of the activities of the
savings banks, all of which in the presence of a housing boom.
Early Repayment
The option to repay part of the mortgage early without incurring in a high cost is usually highly
appreciated by borrowers. However, it can have an important effect on lenders, increasing the
cost in cases of fixed rate funding, as the collateral provided for mortgage backed securities
have to be substituted by similar loans. In general, the more expensive early repayment is, the
less relevant fixed rate mortgages are.
Usually regulation establishes caps on pre-payment penalties for ARM and not for FRM. If these
restrictions are well calibrated, they should be neutral concerning the choice of one modality or
the other. But in practice such calibration is very complicated, with the result that regulation
favors one model or the other.
In some European countries (like the UK and Spain) the law protects borrowers by setting a
low cost for early repayment. Thus, lenders do not have incentives to offer fixed rate
mortgages. In Spain, regulation sets a low cost of early repayment and gives borrowers the
possibility to renegotiate the conditions of their fixed rate mortgages with another bank if the
reference interest rate falls. This is one of the reasons why financial institutions tend to offer
variable rate mortgages.
There are other countries (like Italy) where early repayment is costly and only allowed in some
circumstances. In Germany there is no limit on early payment penalties for FRMs, although no
penalty has to be paid if the property is sold.
With the exception of Denmark, Japan and the US, FRMs are always subject to a prepayment
penalty. In countries such as France and Spain, prepayment penalties are capped.
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Table 1
Prepayment penalties
Country
Amount
Applicability
Penalty Free Payment
Denmark
Yield maintenance
Short term fixed
Germany
Interest margin damage and
reinvestment loss
All fixed rate, not on variable
rate. 10 years maximum
No penalty if property sold
Spain
2.5% up to yield maintenance if
fixed, 0.5% if variable
Fixed and variable
Maximum 10% per year
France
Maximum 6 months interest or
3% of outstanding balance
Fixed and variable
Unemployed, death or job
change
Netherlands Yield maintenance
Fixed
10% per year, hardship or
relocation
UK
2-5% of amount repaid
Discounts and fixed
Canada
Higher or lost interest or 3
months
Lender may waive for own
customer
Up to 20% per year
US
Up to 5% (typically 3%)
Variable
20%
Source: “International Comparison of Mortgage Product Offerings”; M. Lea (2010)
The diversity in the legal regimes of penalties is one of the reasons – together with legal
restrictions in the use of collateral - that precludes the development of a cross-border mortgage
market in the EU. This led the European Commission to consider that early repayment is “one
of the most important issues for integrating EU mortgage markets”. Harmonizing the legal
regime for penalties is crucial to develop a unified mortgage market for the EU or the
Eurozone.
While the European Commission Directive requires Member States to ensure that consumers
have a right to repay their credit before the expiry of the credit agreement, it gives freedom to
Member States to set conditions on the exercise of that right, provided that such conditions are
not excessively onerous. Therefore, the issue remains broadly open and is mainly subject to
the discretion of local legislations.
Caps and floors
In order to avoid default and protect borrowers, regulation can impose caps on variable rates.
In contrast, a floor, a lower limit, tries to protect lenders from important rate drops. In
designing an adequate regulation of caps and floors it is important to make compatible the
contractual freedom of the parties with the consumer protection measures, where they are
necessary. Transparency in the pre-contractual information is crucial to reconcile both
objectives. An adequate regulatory harmonization in the EU would be advisable.
Factors that explain the preference for fixed or
variable rates: the demand and the supply choice
Several studies have analyzed the factors behind the election of fixed or variable rates. Some of
these studies conclude that when the correlation between inflation and real interest rates is
positive and the debt to income ratio is high, borrowers prefer fixed rate mortgages. This
preference, however, depends crucially on country-specific regulation.
Regarding the demand side, one of the main reasons for the preference for ARM is that initial
payments are usually lower. Some borrowers may be myopic to future payments, or have a
higher discount rate. In some cases, variable rate mortgages offer a teaser rate, which is an
artificially low initial interest rate. A teaser rate is an attempt to encourage home purchases in
customers who would otherwise be unable to qualify for a mortgage. It has been blamed for
creating a perverse incentive for unqualified borrowers to buy houses, thus feeding the
housing bubble, particularly in the US. For example, UK banks used to offer variable
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mortgages with a lower rate during the first two years, to attract borrowers whose budget
constraints were higher at the beginning of the loan.
Another reason for choosing ARM is the behavior of interest rates. As the normal slope of the
yield curve is upwards, fixed interest rates are usually higher than variable rates. Borrowers
that simply compare the present level of interest rates may opt for the variable ones.
From the supply side, banks that get funding via deposits tend to favor variable or short term
fixed rate mortgages, in order to reduce their interest rate risk, whereas banks that rely on
wholesale funding through covered bonds or securitizations are usually more prone to FRM.
Chart 2
Developed countries’ mortgage funding % of total
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Germany
Deposits
Netherlands
Canada
Institutional investors
United
Kingdom
Spain
MBS/Mortgage bonds
USA
Denmark
Other
Source: ABS, CHMC, EMF, ESF, FRB, Merrill Lynch Europe
In countries were one kind of mortgage is clearly dominant, it would be beneficial to achieve a
more balanced split between fixed and variable rate mortgages. In order to achieve this target,
the cap on the penalty for early repayment could be lowered (or even eliminated) for FRM.
Also, the offer of mixed rate mortgages (where the rate is fixed for a certain period) could be
encouraged.
Box 1: Spain, wholesale funding and variable rates
In Spain variable rate mortgages are predominant,
despite the fact that the quick development of the
capital markets made long-term funding very
important. The sources of this bias lie on the high and
variable inflation rates at the time of the development
of the system, which implied that ARM was the only
instrument to allow for the necessary lengthening of
the maturities needed to increase affordability. Other
factors explain the importance of variable rates:
Lower initial payments: As the initial payment in
a variable rate mortgage is usually lower than in a
fixed rate one, households with a high discount
rate, with expectations of increase in their relative
income or simply myopic may have incentives to
choose variable rate mortgages.
encouraged them to develop a preference for
variable mortgages.
Early repayment: In Spain borrowers can exercise
early repayment at any time, transfer the loan to
another lender with better conditions, or renegotiate better conditions with the same lender
when interest rates fall. Besides, early repayment
is relatively cheap, as the Bank of Spain set a cap
of the fee to be applied in variable mortgages
when there is no subrogation with another entity.
Interest rate risk is lower for diversified lenders:
Spanish mortgage providers are universal banks,
which can mitigate the interest rate risk as their
portfolio has a wide range of products and not
just mortgages.
Structural reduction of interest rates: Interest
rates decreased sharply from the 1990’s to the
mid 2000’s as a result of entry into EMU.
Borrowers experienced the advantage of ARM in a
context of declining interest rates, which
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3. The financial entities
3.1. Funding: Covered bonds
Since the turn of the century the market for covered bonds has become the most important
segment of privately issued bonds of Europe’s capital markets, with an outstanding volume of
EUR 2.7 trillion at the end of 2011 (roughly 20% of total residential mortgage loans in the EU).
Table 2
Covered bonds outstanding, December 2011 (€ million)
Public Sector
Mortgage
Ships
Mixed Assets
TOTAL
Canada
0
38.610
0
0
38.610
Denmark
0
345.529
5.999
0
351.528
77.835
198.835
0
89.768
365.998
355.673
223.676
6.641
0
585.990
12.999
50.768
0
0
63.767
0
54.243
0
0
54.243
32.657
369.208
0
0
401.865
3.656
194.783
0
0
198.439
0
9.546
0
0
9.546
573.774
21%
1.999.780
75%
12.640
0%
89.768
3%
2.675.962
100%
France
Germany
Italy
Netherlands
Spain
United Kingdom
United States
Total
% of Total
Source: EMF,ECBC
Covered bonds have registered continued growth in most countries as part of banks’ real
estate funding over the last few years, which underlines the increasing importance of this type
of funding. This feature of covered bonds’ markets has been intensified by the international
financial crisis, when most types of securitizations experienced a sudden liquidity dry-up and
issuing activity almost halted, whereas covered bonds displayed a much better behavior and
resilience.
Table 3
Relative size of covered bonds’ markets
% Mortgages
2005
Denmark
% of GDP
2011
2005
2011
100.0
100.0
122.2
146.0
France
11.3
24.1
7.2
18.3
Germany
20.4
22.8
43.5
22.8
0.0
13.8
0.3
4.0
Italy
Netherlands
0.4
14.5
0.4
9.0
31.6
56.1
17.6
37.4
UK
1.9
16.0
1.5
11.0
US
0.0
0.5
0.0
0.1
Spain
Source: EMF, ECBC
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Main features of covered bonds
According to the European Covered Bond Council (ECBC), the essential features of covered
bonds are:
1. Covered bondholders have full recourse to the issuer’s total assets
Full recourse means that the obligor has an unconditional, unrestricted obligation to repay a
debt. Should an obligor fail to do so, the creditor will have a claim on the general insolvency
estate of the obligor on an equal basis with the other general creditors of the obligor. Full
recourse is a key difference between securitization and covered bonds, as in the first case
bondholders’ only recourse is to the cash flows from a securitized portfolio of assets.
In some cases, covered bonds are issued by a special purpose vehicle sponsored by a credit
institution. This provides bondholders with full recourse to the underlying credit institution.
2. Holders of covered bonds have a claim against a specified cover pool of assets
in priority to the issuer’s unsecured creditors
Besides the full recourse mentioned in the previous point, the holders have this additional claim
on part of those assets. The pool of assets that serves as collateral for the covered bonds is a
clearly identified, separated pool of assets dedicated to secure the covered bonds’ payments.
In the event of the insolvency of the credit institution, the assets in the cover pool will be used
to repay the covered bondholders before they are made available for the credit institution’s
3
unsecured creditors .
The most common cover assets are mortgage loans on residential or commercial property,
mortgage loans on ships and loans to public sector entities. In certain countries, cover pools
also include cash and loans on credit institutions.
3. The credit institution must maintain at all times sufficient assets in the cover
pool to satisfy the claims of covered bondholders
The value of the pool of assets must be at least equal to the value of the covered bonds
issued. In most jurisdictions, the value of the cover pool is required to exceed the value of the
covered bonds by a certain amount (this is called “overcollateralization”). Therefore, the credit
institution may be required to add further assets to the cover pool to compensate for matured
or defaulted assets, which does not happen in the case of securitizations.
4. Specific supervision is required for the obligations of the credit institution in
respect of the cover pool of assets
This special supervision is different from the general supervision of the credit institution.
Typically the supervision of the assets used as collateral for the covered bonds include:
Designation of a special cover pool monitor/auditor.
Periodic audits of the cover pool.
On-going management and maintenance of the cover pool to ensure the timely payment
of covered bondholders.
Special public supervision is a condition of Art. 52 (4) of the UCITS directive and of several
other EC directives, making bonds which are subject to special public supervision eligible for
favorable investment limits for certain investors. In addition, for investors subject to the CRD,
only covered bonds subject to special public supervision are eligible for preferential risk
weightings.
3: In the case of Spain, cédulas are guaranteed by the entire mortgage loan book of the issuer. See Table 4.
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The advantages of covered bonds
1. Advantages for the issuer
Cheap and longer term funding compared to other funding sources due to their
overcollateralization, which results in high credit quality. Banks’ credit quality is delinked
from the issuing entity, although the rating of covered bonds is not completely de-linked
from the issuer’s rating.
Investors tend to place larger volumes into covered bonds, which are perceived as safe,
offering higher recovery levels and greater transparency than other types of senior
unsecured bank bonds. Therefore, the issuer can get significant amounts of liquidity.
Market accessibility, especially during and after the financial crisis. Although covered bonds
have suffered as other funding instruments, they have proven to be more resilient.
2. Advantages for the investor
Better credit quality and secondary market liquidity than other instruments during the crisis
International diversification and a large choice of maturities.
Privileged treatment in different areas of EU financial market regulation.
3. Contribution of covered bonds to financial stability
The moral hazard problem of out of balance-sheet securitizations is solved, as the covered
bond issuer still retains the credit risk of the underlying assets used as collateral, being an
on balance-sheet instrument.
The use of covered bonds as collateral in central bank repo transactions has increased,
with lower haircuts than securitizations.
The number of issuers of covered bonds over the last few years has increased, improving
the diversification of funding sources for banks and making credit cheaper and more easily
available for banks’ customers. This helps stabilizing a larger portion of the banking sector.
The volatility of covered bonds is lower than that of the market. Even though the
European sovereign debt crisis has shown that covered bonds and sovereign debt tend to
be closely correlated in times of severe stress, the beta factor of covered bonds is well
below one, so this security is less volatile than the market.
One of the factors that favor the use of covered bonds instead of unsecured debt has to do
with structural subordination.
During the last few years banks have increasingly resorted to covered bonds as the main type
of wholesale funding. This means that more and more assets are separated in order to be used
as collateral for covered bonds. As assets in the cover pool are not available to back the claims
of senior unsecured investors in case of the issuer’s insolvency, investors have started to worry
about the quality of their claims against banks. Depositors and deposit insurers will have a
smaller pool of unencumbered assets, and possibly lower quality assets to fall back on in the
event of a default.
Besides, rating agencies demand high overcollateralization levels in order to provide high
ratings to covered bond issuances, which in most cases significantly exceed the legal
overcollateralization requirements and further reduce not only the available assets for investors
outside the cover pool, but also the available assets for covered bond issuance. In this respect,
the potential volume of covered bonds to be issued by a financial institution is not unlimited, as
the amount of available assets eligible as collateral acts as a restriction.
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However, regardless of the benefits that covered bonds provide, it is important to balance
these benefits against the potential impact of this encumbrance on the issuer’s balance sheet
structure. Analyst estimates (and definitions) of asset encumbrance levels in Europe vary, but
4
averages range between 15 per cent and 25 per cent of assets . This potential disadvantage is
exacerbated, as a result of the crisis, by the current initiative to reform the framework for
banking resolution in Europe, which places considerable emphasis on bail-in as a resolution
tool.
The European Commission has recently published its proposal for a Directive establishing the
framework for the recovery and resolution of banks and financial entities in the EU. This new
legal framework includes among other aspects bail-in and burden-sharing schemes between
banks' shareholders and holders of debt securities.
The aim of a bail-in scheme is that governments and financial authorities have an alternative
option to bail-out, i.e. the rescue of insolvent systemic banks using taxpayers’ money. Bail-in
offers such an option through a mechanism whereby an insufficiently solvent bank can absorb
all (or part of) expected losses by converting some debt categories into equity. This process
avoids a sudden and disorderly liquidation of the bank, which is allowed to continue in
business as a going concern.
The new legal framework for bank resolution is expected to have limited impact on the market
for covered bonds given that all types of collateralized debt will be excluded from the debt
categories to be converted into equity if the bank becomes insolvent. Nevertheless, if banks
increase their use of covered bonds to the detriment of unsecured debt, and reduce the
volume of unsecured funding on their balance sheet, the effectiveness of the new framework
for bank resolution will be adversely impacted.
Generally speaking, covered bonds have been successful due to their simplicity. They are a
plain vanilla product, with a demonstrated track record of high credit quality, typically backed
by mortgages, with strong supervision and regulatory requirements designed to claim
collateral in case the issuing entity fails to honor its debts.
In Spain the use of covered bonds has been intense during the last decade. Spain is the world’s
largest issuer of mortgage covered bonds, with an outstanding volume of EUR 369 billion,
18% of the total at the end of 2011.
Spanish cédulas have been widely used by credit institutions as a cheap and reliable source to
fund their activity for many years. Moreover, the use of covered bonds in Spain has enabled a
fast growing housing market in Spain, which allowed a great share of the population to own
their houses.
We reckon that Spanish cédulas hipotecarias provide a safe and reliable funding source for
financial institutions that include all the positive aspects for both investors and issuers that have
been already mentioned in previous paragraphs. However certain aspects of the legal structure
of other types of covered bonds in Europe (chiefly German pfandbriefe) can be used to further
improve the Spanish framework:
Higher levels of LTV limits in the Spanish legislation for the loans to be eligible for the
cover pool of assets that back the bonds.
The need for a credible due diligence of the dynamic pool of assets that backs the bonds,
which is done in many jurisdictions through “cover monitors” which may adopt the form of
independent auditors.
The need for a provision of sufficient information on the specific loans that make up the
cover pool of assets, which is a characteristic of other counties’ covered bonds, including
information on the substitution of non-performing assets, and the value of the cover pool
4: See Le Leslé (2012).
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Madrid, April 2013
subject to stressed valuations. These stress tests are carried out on a weekly or monthly
basis in other countries. This may be part of the tasks assigned to the “cover monitor”.
In other jurisdictions the cover pool of assets may include money claims up to a certain
limit of the nominal amount of the bonds issued (e.g. 10% in Germany).
In conclusion, some refinements of the mortgage market regulation can be made in Spain to
improve the legal protection of this instrument, moving closer towards the German model.
In order to better understand the strengths and weaknesses of Spain’s cédulas hipotecarias, we
have summarized in table 4 the main aspects of Spanish cédulas compared with the other two
main types of covered bonds in Europe: German pfandbriefe and Danish covered bonds.
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Madrid, April 2013
Table 4
Comparison of the main European covered bond markets
Issuer of the covered
bonds
Recourse of the
bondholder to the issuer’s
total assets
Owner of the cover assets
Assets eligible for the
cover pool
Basis for the calculation of
LTV
Cover pool of assets
Specifics of LTV limits
Mandatory stress test of
the cover pool
What types of stress
scenarios are applied?
Spanish cédulas
Credit institution (universal
and /or specialized
Yes
Yes
The issuer. Cover assets
remain on the issuer’s
balance sheet
The issuer. Cover assets
remain on the issuer’s
balance sheet
Mortgage loans, loans to
public sector, ship loans
and aircraft loans
The issuer. Cover assets
remain on the issuer’s
balance sheet
Mortgage loans, loans to
public sector, ship loans
and aircraft loans
80%75% residential
mortgages; 60%-70%
otherwise
Mortgage loans
80% residential mortgages;
60% otherwise
Monitoring of the cover
pool of assets
Supervisory authority
Reporting obligation
Yes
Overcollateralization
25% minimum at all times
Prepayment of loans using
collateral is allowed
60% all types of collateral
The cover pool is made up
No direct link between
by the entire issuer’s
cover assets and
mortgage portfolio
pfandbriefe
LRV limits refer to issuance
No absolute limit: loans
limits: prohibition to issue
may have a higher LTV
cédulas for an amount
than 60%, but only the
greater that 80% of
amount of the loan up to
outstanding volume of
60% is eligible for the cover
eligible loans
pool
Yes. Legislation requires
No
that bonds are covered on
a net present value basis
Static and dynamic stressed
scenarios, and valuations
Not relevant
based on internal models
(e.g. VaR)
Not relevant
In case of insolvency, how
are covered bondholders
protected?
Universal credit institution
Danish covered bonds
Credit institution (until 2077
only mortgage banks)
Yes
Frequency of stress test
calculations
Requirement for an
independent cover pool
monitor
In case of insolvency do
CBs automatically
accelerate
German pfandbriefe
Weekly
Direct link with the loans.
The cover pool is dynamic
Yes. Legislation requires
that bonds are covered on
a net present value basis
Dynamic stressed
scenarios, and valuations
based on internal models
(e.g. VaR)
Quarterly
Supervisory authority;
trustee or cover pool
Supervisory authority
monitor
Yes. On a quarterly basis
issuers must publish details
of nominal, NPV and
stressed NPV coverage
Yes. Reported to the
level, maturity structure of
supervisory authority
the cover pool and bonds,
as well as data of the
mortgages used as
collateral
2% minimum at all times 8% of Risk Weighted Assets
after stress tests
(only for mortgage banks)
No
Yes
No
No
No
No
Preferential claim: the cover
pool of assets is separated
from the issuer’s general
insolvency estate. Covered
bondholders have primary
secured claim against all
assets in the cover pool.
Preferential claim by law.
Besides, there is specific
cover pool administration
by the cover pool monitor
Preferential claim: the cover
pool of assets is separated
from the issuer’s general
insolvency estate. Covered
bondholders have primary
secured claim against all
assets in the cover pool.
Yes, but usually with
penalization. Prepayment of
mortgages during fixed rate
periods are allowed in cases
of “legitimate interest of the
borrower” or after a period
of 10 years.
At all times
Source: ECBC
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4. The mortgage client: Consumer
protection and tax treatment
4.1. Consumer Protection
Proliferation of new regulation
With the trigger of the international crisis, authorities have taken numerous initiatives to better
regulate mortgage practices, also in relation to consumer protection. However, there is a risk
of duplication or incoherence between measures adopted.
After the release of a thematic review on mortgage underwriting and origination practices
(March 2011), the Financial Stability Board (FSB) issued a consultation paper (October 2011)
with the aim to implement five principles for sound residential mortgage underwriting
practices. The principles remain general and subject to national supervisor discretion, and
cover issues such as effective verification of income, reasonable debt service coverage,
appropriate loan-to-value ratios, effective collateral management and prudent use of mortgage
insurance. The report also encourages the use of loan-to-value ratios and debt service limits.
At national level, the United States has issued numerous proposals. The Federal Reserve
Board implemented some guidelines for high cost loans in 2008, including a prohibition of prepayment penalties on high cost loans. Furthermore, the Dodd-Frank Financial Reform Bill (July
2010) introduced a differentiation between “qualified” and “non-qualified” mortgages in its
section “Mortgage Reform and Anti-Predatory Lending Act”:
“Qualified mortgage” are instruments with low risk features whether they have a fixed
(FRM) or adjustable rate (ARM): fully amortizing payments and a term no longer than 30
years. In those cases, borrowers’ total monthly debt payments must be below 43% of their
total monthly pre-tax income. Pre-payment penalties are now capped on “qualified” FRM
and prohibited on ARM. Regulators can restrict or prohibit the use of, among others,
balloon payments; negative amortization; pre-payment penalties; interest-only payments.
While “non-qualified” mortgages are still allowed, they are subject to certain limitations: prepayment penalties are prohibited and lenders must retain at least five per cent of the credit
risk on the loans. Its offer will be limited, since those would show a higher price that
reflects the requirement of risk retention; a greater risk of provision violation; and a greater
cost of disclosure and compliance.
In January 2013 the US consumer regulator has reinforced its requirements so as to provide
lenders with a greater shield from potential lawsuits, with the target to get easier credit terms
for borrowers. In particular, the Consumer Financial Protection Bureau published its Ability-toRepay rule, to be implemented by January 2014. Lenders must consider eight underwriting
factors (expected income, employment status, monthly payment -of the transaction, of
simultaneous loans and of mortgage related obligations-, current obligations –debt, alimony
and child support, monthly debt-to-income or residual income and credit history), financial
institutions must verify income and they have seen their ability to impose prepayment penalties
limited.
Before the financial crisis, European Member States independently transposed to national
mortgage markets parts of the EU Consumer Credit Directive (CCD). This consists in a
moderately interventionist approach, which regulates pre-contractual transparency and certain
contractual issues, but leaves out contract execution via foreclosure and the consumer
insolvency regime, and is not directly applicable to mortgages.
The European Commission (EC) has elaborated a proposal of Directive on credit agreements
relating to residential property in March 2011. On April 22nd, 2013 the European
Parliament, the Council and the Commission reached an agreement on the Directive. Creditors
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Madrid, April 2013
will be obliged to hand out to consumers a standardised information sheet (ESIS) that will allow
them to shop around to identify the best and cheapest credit offer for their needs. The
Directive also creates an obligation for creditors and intermediaries to make general
information available on the range of credit products, and makes the right of early repayment
compulsory (while Member States will have the choice to impose that creditors should receive
a fair compensation). However, it does not handle critical issues such as rate adjustments and
caps for ARM or cross-border mortgages with foreign collateral.
The proliferation of regulatory initiatives risks producing a regulatory conflict, mostly in
Europe. Although since markets show different background in terms of real estate structure,
cultural features and socioeconomic policies, some leeway must be provided to national
supervisors, the project of a Banking Union in the Eurozone would probably require a much
more ambitious harmonization. In fact, the European mortgage markets remain still highly
fragmented, as shown by chart 3. In an integrated market, prices should theoretically
converge because of competition between financial providers, which is clearly not the case.
Chart 3
Interest rate, Annual Percentage Rate of Change (APRC): lending for house purchase (%)
Austria, Euro
Portugal, Euro
Germany, Euro
Spain, Euro
Ireland, Euro
France, Euro
Greece (GR), Euro
Italy, Euro
2012Oct
2012Mar
0
2011Aug
0
2011Jan
1
2010Jun
1
2009Nov
2
2009Apr
2
2008Sep
3
2008Feb
3
2007Jul
4
2006Dec
4
2006May
5
2005Oct
5
2005Mar
6
2004Aug
6
2004Jan
7
2003Jun
7
Netherlands, Euro
Source: ECB, BBVA Research
Responsible lending
What is responsible lending?
Responsible lending are those practices intended at making sure that credit products are
appropriate to consumers’ needs and tailored to their ability to repay. They cover two sets of
issues:
Banks must assess the affordability of all mortgages and make sure that clients have all the
information needed.
Consumers must get information about the products, provide complete and accurate
information on their financial situation and take their circumstances into account when
making their decision.
During the last few years and in particular since the crisis started, several public and private
initiatives have pointed at bad practices in the market. This is the case of the FSA Mortgage
5
Market Review or the European Commission Public Consultation on Responsible Lending and
6
Borrowing in the EU . Some of the bad practices identified were: Irresponsible mortgage
5: FSA, CP10/16: “Mortgage Market Review: Responsible Lending” (July 2010)
6: European Commission, “Public Consultation on Responsible Lending and Borrowing in the EU”, November 2009
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Madrid, April 2013
products such as self-certification mortgages (with no prove of income), uncapped variable rate
mortgages, loans in excess of 100% of the value of the property (LTV), failure to calculate
Annual Percentage Rate of Change (APRC), the promotion of 0% introductory interest rate,
7
interest free credit or interest-only mortgages or risky foreign currency loans.
What causes irresponsible lending in theory?
In theory, the current weaknesses of mortgage markets were caused by market failures and
regulatory gaps. This makes difficult the functioning of the EU single market by: (i) preventing
the pursuit of business or (ii) raising the cost of doing business cross-border
Chart 4
CONSEQUENCES
PROBLEMS
DRIVERS
Channels between irresponsible lending and financial stability
MARKET FAILURE
innapropriate
advertising
and
marketing
innapropriate
precontractual
information
Risk of consumer
detriment
REGULATORY FAILURE
provision of
innapropriate
advice
inadequate
creditworthi
ness
assessment
Low customer mobility
RISK OF FINANCIAL INSTABILITY
inconsistent
early
repayment
option
Gaps in authorisation and
supervision regimes of:
Non credit
institution
lenders
Low cross-border activity
credit
intermediarie
s
Unlevel playing field
between market
actors
NO SINGLE MARKET WITH A HIGH LEVEL OF
CONSUMER PROTECTION FOR MORTGAGE CREDIT
Source: European Commission (2011), BBVA Research
Market failures:
Information asymmetries: the creditor is better informed than the borrower about the
mortgage, while the customer is better informed about his financial situation.
Misaligned incentives: Creditors’ interest may be biased by their remuneration
schemes, which may lead to inappropriate creditworthiness or suitability assessment.
Regulatory failures:
Regulation should ensure adequate competition, addressing market failures like:
1. Inappropriate advertising and marketing. Advertising can encourage inappropriate
products for the consumers or fail to help consumers to understand and compare
offers, in particular cross-border.
2. Inappropriate pre-contractual information: Consumer should understand the
features and risks of mortgage products; be able to compare offers and to make
an informed choice.
One of the main information to be provided prior the execution of a contract is the
8
annual percentage rate of charge (APRC) which is the total cost of the credit to
the customer in terms of the total amount of credit. Currently, there is no
7: In the UK at the peak of the market over 30% of all mortgages were interest-only. In Denmark, the Netherlands and the UK, the loan
can be interest only to maturity (maximum 30 years). However, in the Netherlands these mortgages have a maximum 75% LTV.
8: Equivalent to the Spanish TAE, the most significant transparency measure adopted in Spain in the seventies.
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Madrid, April 2013
European legislation that harmonizes its calculation, but there is a legal
specification for its calculation in most countries (but the Netherlands).
9
3. Inadequate creditworthiness assessment: Legislations vary across countries . The
European directive sets the obligation to exercise a creditworthiness assessment
prior to the execution of a mortgage and to communicate it to customers.
Mortgage credit providers will also need to respect high-level principles in their
direct contacts with their clients, such as taking account of the consumer’s real
interests, ensuring that the remuneration structures do not incite excessive risk
taking, and disclosing any links between the credit intermediary and the creditor.
4. Repayment right: The European directive sets the obligation to ensure this right to
customers, but it does not define the conditions under which it could be executed.
In fact, Member States will have the choice to impose that in such cases creditors
should receive a fair compensation. This is related to the debate ARM vs. FRM
models (see section 2).
What are the recommendations of authorities?
Regulators in most areas
grouped in:
10
are taking steps to ensure responsible lending, which can be
Making sure that banks perform affordability tests, as they are responsible for assessing
their clients’ ability to pay. In the EU, lenders are required to refuse credit if the borrowers
cannot demonstrate their ability to repay the loan.
Ensuring that clients have all relevant information to take adequate borrowing decisions
In some cases, introducing extra protection for vulnerable clients, like those with a creditimpaired history.
Affordability tests usually include an assessment of clients’ income and expenditure. Some
analysts are requiring these tests to be performed several times during the life of the project,
and not only when it is being granted.
Income: This includes verifying income for all mortgage applications, which in practice
bans self-certification and fast-track mortgages. Income evidence must be from a source
independent of the client.
Expenditure: A line-by-line assessment of all expenditure data has important practical
difficulties, so lenders are often allowed to use statistical data and their own expenditure
models.
Other conditions: In the UK, assessments must normally be based on a capital and
interest basis, and on a maximum term of 25 years.
In particular, the Bank of Spain has just published (July 2012) a “Circular on transparency and
responsibility in lending”. Some of the general principles of responsible lending to individuals
are:
The customers’ ability to repay must be part of the granting criteria and of the process to
set the maximum available credit. Income considered must be that from regular sources,
using reliable and updated information. This concept was already introduced in the Law of
Sustainable Economy (March 2011).
9: As of March 2011, some extended the CCD requirements to mortgage products, among others: Belgium, Denmark, Germany, Italy,
Netherlands, and Sweden. Other countries have adopted similar provisions: Czech Republic, Greece, Ireland, Lithuania, Poland, UK.
However, three countries have not adopted any provision to require an adequate assessment of creditworthiness: France, Luxembourg
and Portugal. In Spain the execution of a creditworthiness assessment is mandatory from 2011 with the adoption of the 2/2011 Law
Sustainable Economy
10: In the case of the EU, the Commission adopted a proposal for a Directive on credit agreements relating to residential property in
March 2011 along these lines. Once Parliament and Council adopted it, EU member countries must implement national measures to
achieve the results stipulated by the directive.
In the case of the UK, the PS12/16 “Mortgage Market Review – feedback on CP11/31 and final rules” (Oct 2012)will come into effect on
26 April 2014. All customers will need to satisfy lenders that they can afford the mortgage, and provide evidence of their income. Most
mortgage sales will require advice. The new rules do not prevent higher loan-to-value lending or lending to old clients, and interest-only
will be allowed if the borrower can show that they have a credible repayment strategy.
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Payment plans should be realistic and coherent with the income of clients, which should
be able to afford living costs.
LTV should be prudent, taking into account the amount of the loan (and its potential
enlargements) and the value and risks inherent to the collateral. Initial down payment must
be sufficient.
The procedures for the valuation of the collateral must be adequate, and there must be a
policy to pursue the quality of the appraisal values. Special attention must be taken to
foreign currency mortgages and potential interest rate variations.
In the case of offers of risk coverage products, like interest rate swaps, the entity must
inform the client of coming payments and opt-out options.
In the case of credit granted to a constructor which will be subrogated to housing
acquirers, the bank must make sure that mortgage clients have all the information they
need and assess their payment capacity.
Entities should provide the client with sufficient information for them to take an informed
decision and to be able to compare the offer with similar ones.
As a result of the crisis, lenders are tightening guidelines in many countries:
Some very common practices consist on imposing LTV caps, loan-to-income caps,
mortgage quote-to-income caps, term caps or restrictions to offering certain types of
mortgages, like interest-only mortgages. However, this can be intrusive, as it has been the
case in some Asian countries.
Canada: In June 2012, the government decided reducing the maximum amortization
11
period for insured mortgages from 30 to 25 years, lowering the maximum amount
withdraw in refinancing an insured mortgage from 85% to 80% of the value of their
homes and setting the maximum gross debt service ratio at 39%. The minimum down
payment remains at 5% for owner-occupied properties and 20% for speculative properties.
United Kingdom: The FSA recognised in 2009 that the usefulness of LTV or debt-toincome (DTI) caps are not yet warranted by the evidence. They recommend restrictions on
risk layering (prohibiting loans that are a mix of high-risk factors, for example, prohibiting
high LTV loans to credit-impaired borrowers who have an unstable income or other similar
“toxic” mixes) and requiring income verification on all mortgages.
The following table presents a summary of recent measures related to responsible lending,
some of which have been taken at the initiative of the banks:
Table 5
Change in Mortgage Product Characteristics, Late 2007–Late 2008
Country
Loan to
Max
Reduction in
Interest
Lower Loan-to-
100% Mortgages
Income Criteria
Mortgage Term
Only Loan
Value Ratios
Less Available
Tightened
Shortened
Availability
Denmark
x
France
x
Netherlands
x
x
x
x
x
Spain
x
U.K.
x
x
x
x
U.S.
x
x
x
x
x
x
Source: Scanlon et.al. 2009
11: The government of Canada provides insurance to protect mortgage lenders against mortgage defaults on mortgages for which
insurance has been purchased (mandatory on loans with less than 20% down although lenders may require it on loans with more than
20% equity if they perceive additional risk of default).
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4.2. Tax Regime
There are several ways in which governments encourage housing investment and improve
households’ affordability: subsidized mortgages, deduction of interest payments in the income
tax, capital grants and by constructing or supporting the construction of subsidized houses.
However, there are significant differences in the taxation of housing-related activities in different
countries, as can be seen in the table 6 below.
Table 6
Housing market related taxation (*)
Capital gains tax
Tax
On
Tax deducti- selling
on
bility of
own
imput interest home
ed
payafter 10
rent
ments
years.
Inheritance tax
Different
Different
treatme Maxitreatment
nt of mum tax
of
financial
rate
On
financial
housing aplicaown
housing
assets
ble
home
assets
Germany
no
no
no
yes
45%
yes
yes
Spain
no
yes*
yes
yes
18%
yes
France
no
yes
no
yes
16%
yes
Italy
no
yes
no
yes
20%
Netherlands
yes
yes
no
no
Denmark
no
yes
no
no
US
no
no
no
yes
24%
Canada
no
yes
no
Residential
property
Transact
prices
Real
ion
Rented average
estate/ tax/fee/ Owner accomo- growth
Wealth property stamp ocupan- dation, 1999tax
tax
duty
cy rate
latest
2007
no
yes
yes
43.0
yes
no
yes
yes
no
yes
yes
yes
yes
yes
no
yes
n.a.
yes
yes
no
42%
yes
yes
no
24%
no
yes
no
58.4
-0.4
86.3
9.3
11.9
57.2
42.8
10.3
yes
69.1
18.8
6.3
yes
yes
56.6
43.0
8.1
yes
yes
54.0
36.0
11.6
yes
yes
68.4
33.7
7.7
yes
yes
67.0
33.0
7.0
(*) In general, the tax issues of the table 6 refer to the main house.
Source: NCBs and International Bureau of Fiscal Documentation
Only a few euro area countries have a tax on imputed rent for owner-occupied houses (like
the Netherlands). However, most countries impose a property tax that has a similar effect.
In the majority of countries, mortgage interest payments are tax-deductible, although this
is usually restricted to primary residences. This subsidization improves the affordability,
and has implications on the size of the mortgage that households take up, the number of
households with a mortgage and the types of loans involved (e.g. interest-only loans). On
the other hand, it introduces a bias towards owner-occupied housing and against renting,
which is arguably a factor behind some of the recent bubbles; although the link between
tax deductibility and rise in house prices is not totally clear (see charts below). A too high
owner occupancy rate affects negatively the mobility of workers, exacerbating already high
labor market rigidity in countries such as Spain.
In general, capital gains on the principal owner-occupied home are exempted from the
capital gains tax, especially if the owner has lived there for several years before selling it.
Inheritance/gift tax, as well as wealth tax, may have an impact on the volume of
mortgages that households take out. Most countries have stopped collecting inheritance
12
and wealth taxes over the past decade .
Taxes on property transactions are present in most countries. Most often, these are one-off
fees, such as stamp duties on the home purchase contract or transfer taxes on real estate
transactions. In some cases, as in Ireland, rates of stamp duty are used as a policy
instrument to curb housing demand.
Transaction costs (purchase costs and mortgages costs) may have an effect on housing
market activity. The former are usually largest in size, and comprise mainly taxes (see
above). On average, taxes account for up to two-thirds of the transaction costs, but this
12: However, inheritance tax has recently been reintroduced in Italy.
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Madrid, April 2013
part is particularly high in Greece, Spain and France. Apart from affecting housing market
activity, high transaction costs may also have negative effects on labor mobility.
In summary, tax policies often promote home ownership through fiscal instruments that favor
investment in property over investment in financial assets, due to their positive external effects.
Furthermore, it is evident that fiscal aspects of mortgage financing are predominantly countryspecific and play an important role in housing markets’ development.
The owner-occupancy rate is very heterogeneous in Europe. Rates are very low in Germany
(43%), low in France, Netherlands, Austria and Finland (55 to 60%). In these countries,
households are highly active in renting out their houses. For example, German households
own about 75% of all residential property, but only 43% live in their own home. In this
country, 30% of existing houses are rented out by private individuals and 18% that by private
enterprises.
There are many variables that affect positively the rate of property and mortgage market
development, so it is not easy to quantify the impact of the tax benefits, as show in Chart 5.
Similarly the relation between the growth of housing prices and tax deductibility is not clear, as
show in Chart 6.
Chart 5
Tax deductibility vs. Owner rate
Chart 6
Tax deductibility vs. Housing price
14
Average growth nominal housing
price 1999-2007
Owner occupacy rate %
90
80
70
60
50
40
30
YES
NO
12
10
8
6
4
2
0
-2
NO
Tax deductibility
Tax deductibility
Source: BBVA Research
YES
Source: BBVA Research
However, in countries with a higher proportion of rented accommodation or a lower property
rate, house prices growth during the recent boom period was lower, at least ceteris paribus
and in the period considered (charts 7 and 8). One of the risks of an active government policy
to encourage home ownership may be the development of a higher propensity to housing
bubbles. This is usually associated with problems of financial stability and can derive in
negative effects on the real economy once the bubble explodes. The development of the rental
market and a neutral tax treatment of property vs. rent seems to be a good practice. The
elimination of tax deductions for the purchase of new houses by the Spanish government in
July 2012 is in line with this consensus.
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Chart 7
Chart 8
Housing price vs. Owner property rates
12
10
8
6
4
2
0
-2
0
Source: BBVA Research
50
Owner property rates
100
Average growth nominal housing
price
1999-2007
14
y = 0.1909x - 5.0587
R² = 0.3476
14
Average growth nominal housing
price
1999-2007
Housing price vs. Rented accommodation
y = -0.1619x + 12.555
R² = 0.3362
12
10
8
6
4
2
0
-2
0
20
40
60
80
% rented accommodation
Source: BBVA Research
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Box 2. Examples of income tax deductibility of mortgage interest payments
Germany: Mortgage interest is not deductible in the
case of owner-occupied housing, but only in the case
of rented houses (in the calculation of the rental
income received by the taxpayer).
Spain: Home-owners can deduct, from their net tax
payable, 15% of the first €9,015 spent every year on
interest and principal repayments. Before 2007 and if
the loan financed more than 50% of the total
purchase value, the deduction for the first €4,508 was
25% during the first two years, and 20% for the rest
of the life of the loan. The 15% rate was applied to the
remaining €4,508 in all cases. There is no deduction
for secondary residences. In July 2012 the
government removed this tax deduction for new
purchases.
nd
France: For loans extended as of 22 August 2007
for the purchase or construction of a main residence,
the interest paid generates a tax credit during the first
five years. The tax credit is calculated as 20% (40%
for the first year) of the qualifying loan interest. The
qualifying interest is limited to €7,500 per couple,
plus €500 per dependent.
Italy: There is a tax credit equal to a maximum of
€760 (19% of €4,000) due to interest paid in relation
to the main residence.
Netherlands: For mortgages on prime residences, the
interest is income-deductible for a maximum period of
30 years. The size of the mortgage can be increased
for the maintenance or improvement in the case of an
owner-occupied dwelling, being the interest on this
increase fully deductible.
USA: Qualified mortgage interests can be deducted,
both in the case of a main or a second home,
although there are exceptions. Home mortgage
interest is that resulting from a debt that is secured by
a main or second home. Acquisition debt is debt
incurred to buy, build, or improve a home, while
home-equity debt is debt incurred for any other
purpose. It can also be deducted called “deducting
points” that are equivalent to the mortgage interest,
such as loan-origination fees, maximum loan charges,
and loan discounts.
Canada: Mortgage interest is not deductible in the
case of owner-occupied housing. When the property is
for rent, mortgage interest and other expenses
associated with the property (property taxes, utility
cost, house insurance…) can be deducted of the rental
income received by the taxpayer.
Denmark: Mortgage interest paid by the owner is taxdeductible when calculating capital income. The
current tax relief on interest has a taxable value of
approximately 33%. Property value tax is not part of
the income tax but the calculated property value tax is
collected with income taxes. Property tax is 1% of the
part of the property value that does not exceed an
amount of DKK 3,040,000 and 3% of the rest, so it is
progressive.
Page 24
Working Paper
Madrid, April 2013
5. Mortgage regulation and
macroprudential oversight
The 2007–08 financial crisis has triggered an increasing awareness of the importance of
systemic risk and macroprudential policies. Financial stability requires not only appropriate
policies on the traditional microprudential sphere (that deals with individual banks) but also for
the system as a whole. Although no consensus has been reached on whether macroprudential
policies should be set to deal with asset bubbles, a wide variety of macroprudential tools have
already been used in many countries.
The link between macroprudential policies and mortgage market regulation is straightforward.
A significant number of recent crises were originated in the real-estate sector, where asset
prices booms are relatively frequent.
In a context of abnormally low interest rates, mortgage credit showed a rapid expansion from
2000 to 2007 in a number of countries, from the US to UK, Spain or Ireland. An increasing
percentage of new loans were granted with a high LTV ratio and therefore a high risk profile.
This exacerbated the housing sector bubble and the effects of the economic cycle. The
following graph shows that loan-to-value ratio varies widely across European countries.
Chart 9
Average LTV on new credit for house purchase during the financial crisis
80
70
60
50
40
30
20
10
0
Euro Area
Portugal
UK
Greece
Spain
Italy
Germany
France
Source: ECFIN Retail Banking Survey, 2009 Q1, EC (2011) and BBVA Research
As it has been mentioned before, in order to avoid excessive lending and housing prices
bubbles, loan-to-value caps have been adopted in a number of countries. Before the crisis,
many Asian countries implemented LTV limits to smooth real estate booms (e.g. China: limits
varying between 70% and 80%; Hong-Kong: limits between 60% and 70%; and Korea: LTV
capped at 50%). Some of these countries adjusted these limits to counteract housing bubbles.
In contrast, advanced economies have been more reluctant to establish such limits, which are
seen as an intrusive measure, which curtails the contractual freedom of the parties. Among
developed countries, only Denmark and more recently Canada and Sweden, introduced LTV
13
caps. Some international initiatives propose the use of this instrument as regular tool to limit
asset prices bubbles.
LTV limits are appealing as a policy instrument because of their effectiveness, but their use
must be well calibrated in order to minimize their drawbacks. The implementation of loan-tovalue limits may push lending to the unregulated sector and by this way exacerbate shadow
banking (e.g. in Croatia, where the introduction of a 75% LTV cap was unsuccessful since it
13:Such as the proposal of the High-level Expert Group on reforming the structure of the EU banking sector, better known as the
Liikanen Group]
Page 25
Working Paper
Madrid, April 2013
encouraged consumers to find unsecured ways of funding). One solution to minimize these
effects could consist in implementing mortgage insurance above a given LTV threshold, which
discourages lending above such limit and protects banks from losses. This type of instrument
has already proven its virtues in Canada and Hong Kong. Many Asiatic countries (China, Korea)
also introduced debt-to-income caps to deal with price bubbles in the mortgage sector. The
effectiveness and the drawbacks of such instrument are similar to those related to LTV limits.
All in all, LTV limits proved to be an effective policy tool in emerging markets that can have,
however, unintended effects on efficiency, competition and the level playing field between the
regulated and the unregulated sectors. Their usefulness in more developed financial systems,
where competition is much higher and potential loopholes abound, remains to be seen,
however. For these types of countries, a regulation based on incentives rather than
prohibitions seems more in line with the business environment. In these cases, instead of caps
to LTV, incentives for a prudent underwriting have been used: higher capital requirements for
higher LTV, or securitization requirements based on a maximum LTV.
Other macroprudential tools have been used with the aim to control price bubbles in the
mortgage sector. In that vein, many Eastern European countries set some capital control
mechanisms in the form of stricter requirements on foreign lending, which mainly resulted to
provide poor results. At the beginning of the past decade, many of those countries showed a
vast increase in credit growth along with increased levels of external indebtedness. These
features were mainly explained by the massive foreign lending through their banking system
which was mostly channelled to their real estate sector. Authorities reacted by adopting several
measures to curb bank lending in foreign currency: they implemented stricter capital
14
requirements and higher LTV limits for foreign currency loans . Since these capital control
mechanisms were highly intrusive and were adopted too late, the results were not satisfactory.
Although macroprudential tools are necessary to deal with credit bubbles, the Eastern
European experience conveyed the importance to distinguish macroprudential policies from
intrusive capital controls and that a right calibration and early adoption of macroprudential
tools are crucial to ensure their effectiveness.
The Spanish experience with dynamic provisions has been a reference in the debate on
15
macroprudential policies . In the early years of the 2000s, the Spanish authorities saw with
increasing anxiety the combination of high credit growth, inflation differentials with the
Eurozone average, loss of competitiveness, and widening current account deficits. Dynamic
provisions were therefore adopted as a prudential instrument to achieve a systemic or
macroeconomic goal, i.e. limiting credit growth especially originated in the mortgage sector.
The goal of the instrument was twofold: (i) to contain credit growth, by increasing the cost of
the granting of new credit, and (ii) to protect Spanish banking institutions from future losses as
a consequence of the relaxation of lending standards typical of the boom phase. Although the
instrument was not completely successful because of the severity and length of the actual
crisis, the virtues of the Spanish dynamic provision mechanism should be recognized. Peru
and Colombia have also adopted a dynamic provisioning system with similarities and
differences from the Spanish mechanism, but it is not possible to assess their effectiveness yet,
since they have not experienced a whole business cycle.
14: Higher capital requirements for foreign loans: Romania 2004 & 2010, Hungary 2008, Poland 2008 & 2012, Latvia 2009, Albania
2008. Higher LTV for foreign mortgage loans (Hungary 2010) or DTI (Romania 2008, Hungary 2010, Poland 2010 and 2012).
Outright ban on new foreign loans: Hungary 2010
15: See Fernández de Lis and García-Herrero (2012).
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Working Paper
Madrid, April 2013
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Working Papers
2013
13/01 Hugo Perea, David Tuesta y Alfonso Ugarte: Lineamientos para impulsar el Crédito y
el Ahorro. Perú.
13/02 Ángel de la Fuente: A mixed splicing procedure for economic time series.
13/03 Ángel de la Fuente: El sistema de financiación regional: la liquidación de 2010 y
algunas reflexiones sobre la reciente reforma.
13/04 Santiago Fernández de Lis, Adriana Haring, Gloria Sorensen, David Tuesta, Alfonso
Ugarte: Lineamientos para impulsar el proceso de profundización bancaria en Uruguay.
13/05 Matt Ferchen, Alicia Garcia-Herrero and Mario Nigrinis: Evaluating Latin America’s
Commodity Dependence on China.
13/06 K.C. Fung, Alicia Garcia-Herrero, Mario Nigrinis Ospina: Latin American Commodity
Export Concentration: Is There a China Effect?.
13/07 Hugo Perea, David Tuesta and Alfonso Ugarte: Credit and Savings in Peru.
13/08 Santiago Fernández de Lis, Adriana Haring, Gloria Sorensen, David Tuesta, Alfonso
Ugarte: Banking penetration in Uruguay.
13/09 Javier Alonso, María Lamuedra y David Tuesta: Potencialidad del desarrollo de
hipotecas inversas: el caso de Chile.
13/10 Ángel de la Fuente: La evolución de la financiación de las comunidades autónomas de
régimen común, 2002-2010.
13/11 Javier Alonso, María Lamuedra y David Tuesta: Potentiality of reverse mortgages to
supplement pension: the case of Chile.
13/12 Javier Alonso y David Tuesta, Diego Torres, Begoña Villamide: Proyecciones de
tablas generacionales dinámicas y riesgo de longevidad en Chile.
13/13 Alicia Garcia Herrero and Fielding Chen: Euro-area banks’ cross-border lending in the
wake of the sovereign crisis.
13/14 Maximo Camacho, Marcos Dal Bianco, Jaime Martínez-Martín: Short-Run Forecasting
of Argentine GDP Growth.
13/15 Javier Alonso y David Tuesta, Diego Torres, Begoña Villamide: Projections of
dynamic generational tables and longevity risk in Chile.
13/16 Ángel de la Fuente: Las finanzas autonómicas en boom y en crisis (2003-12).
13/17 Santiago Fernández de Lis, Saifeddine Chaibi, Jose Félix Izquierdo, Félix Lores, Ana
Rubio and Jaime Zurita: Some international trends in the regulation of mortgage markets:
Implications for Spain.
2012
12/01 Marcos Dal Bianco, Máximo Camacho and Gabriel Pérez-Quiros: Short-run forecasting
of the euro-dollar exchange rate with economic fundamentals. / Publicado en Journal of
International Money and Finance, Vol.31(2), marzo 2012, 377-396.
12/02 Guoying Deng, Zhigang Li and Guangliang Ye: Mortgage Rate and the Choice of
Mortgage Length: Quasi-experimental Evidence from Chinese Transaction-level Data.
12/03 George Chouliarakis and Mónica Correa-López: A Fair Wage Model of Unemployment
with Inertia in Fairness Perceptions. / Updated version to be published in Oxford Economic
Papers: http://oep.oxfordjournals.org/.
12/04 Nathalie Aminian, K.C. Fung, Alicia García-Herrero, Francis NG: Trade in services:
East Asian and Latin American Experiences.
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Working Paper
Madrid, April 2013
12/05 Javier Alonso, Miguel Angel Caballero, Li Hui, María Claudia Llanes, David Tuesta,
Yuwei Hu and Yun Cao: Potential outcomes of private pension developments in China
(Chinese Version).
12/06 Alicia Garcia-Herrero, Yingyi Tsai and Xia Le: RMB Internationalization: What is in for
Taiwan?.
12/07 K.C. Fung, Alicia Garcia-Herrero, Mario Nigrinis Ospina: Latin American Commodity
Export Concentration: Is There a China Effect?.
12/08 Matt Ferchen, Alicia Garcia-Herrero and Mario Nigrinis: Evaluating Latin America’s
Commodity Dependence on China.
12/09 Zhigang Li, Xiaohua Yu, Yinchu Zeng and Rainer Holst: Estimating transport costs and
trade barriers in China: Direct evidence from Chinese agricultural traders.
12/10 Maximo Camacho and Jaime Martinez-Martin: Forecasting US GDP from small-scale
factor models in real time.
12/11 J.E. Boscá, R. Doménech and J. Ferria: Fiscal Devaluations in EMU.
12/12 Ángel de la Fuente and Rafael Doménech: The financial impact of Spanish pension
reform: A quick estimate.
12/13 Biliana Alexandrova-Kabadjova, Sara G. Castellanos Pascacio, Alma L. GarcíaAlmanza: The Adoption Process of Payment Cards -An Agent- Based Approach. /
B.Alexandrova-Kabadjova, S. Martinez-Jaramillo, A. L. García-Almanza y E. Tsang (eds.)
Simulation in Computational Finance and Economics: Tools and Emerging Applications, IGI
Global, cap. 1, 1-28 ( Ver: IGI Global )
12/14 Biliana Alexandrova-Kabadjova, Sara G. Castellanos Pascacio, Alma L. GarcíaAlmanza: El proceso de adopción de tarjetas de pago: un enfoque basado en agentes.
12/15 Sara G. Castellanos, F. Javier Morales y Mariana A. Torán: Análisis del uso de
servicios financieros por parte de las empresas en México: ¿Qué nos dice el Censo Económico
2009? / Publicado en Bienestar y Política Social, Vol. 8(2), 3-44. Disponible también en inglés:
Wellbeing and Social Policy, Vol. 8(2), 3-44.
12/16 Sara G. Castellanos, F. Javier Morales y Mariana A. Torán: Analysis of the Use of
Financial Services by Companies in Mexico: What does the 2009 Economic Census tell us?
12/17 R. Doménech: Las Perspectivas de la Economía Española en 2012:
12/18 Chen Shiyuan, Zhou Yinggang: Revelation of the bond market (Chinese version).
12/19 Zhouying Gang, Chen Shiyuan: On the development strategy of the government bond
market in China (Chinese version).
12/20 Angel de la Fuente and Rafael Doménech: Educational Attainment in the OECD, 19602010.
12/21 Ángel de la Fuente: Series enlazadas de los principales agregados nacionales de la EPA,
1964-2009.
12/22 Santiago Fernández de Lis and Alicia Garcia-Herrero: Dynamic provisioning: a buffer
rather than a countercyclical tool?.
12/23 Ángel de la Fuente: El nuevo sistema de financiación de las Comunidades Autónomas
de régimen común: un análisis crítico y datos homogéneos para 2009 y 2010.
12/24 Beatriz Irene Balmaseda Pérez y Lizbeth Necoechea Hasfield: Metodología de
estimación del número de clientes del Sistema Bancario en México.
12/25 Ángel de la Fuente: Series enlazadas de empleo y VAB para España, 1955-2010.
12/26 Oscar Arce, José Manuel Campa y Ángel Gavilán: Macroeconomic Adjustment under
Loose Financing Conditions in the Construction Sector.
12/27 Ángel de la Fuente: Algunas propuestas para la reforma del sistema de financiación de
las comunidades autónomas de régimen común.
Page 30
Working Paper
Madrid, April 2013
12/28 Amparo Castelló-Climent, Rafael Doménech: Human Capital and Income Inequality:
Some Facts and Some Puzzles.
12/29 Mónica Correa-López y Rafael Doménech: La Internacionalización de las Empresas
Españolas.
12/30 Mónica Correa-López y Rafael Doménech: The Internationalisation of Spanish Firms.
12/31 Robert Holzmann, Richard Hinz and David Tuesta: Early Lessons from Country
Experience with Matching Contribution Schemes for Pensions.
12/32 Luis Carranza, Ángel Melguizo and David Tuesta: Matching Contributions for Pensions
in Colombia, Mexico, and Peru: Experiences and Prospects.
12/33 Robert Holzmann, Richard Hinz y David Tuesta: Primeras lecciones de la experiencia
de países con sistemas de pensiones basados en cotizaciones compartidas.
12/34 Luis Carranza, Ángel Melguizo y David Tuesta: Aportaciones compartidas para
pensiones en Colombia, México y Perú: Experiencias y perspectivas.
Click here to access the list of Working Papers published between 2009 and 2011
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